Bankruptcy is a court process that allows an individual or business to get relief from their debts. The ultimate goal of bankruptcy is to give the individual or business a fresh financial start while being fair to creditors.
There are two ways a business can file for bankruptcy: Chapter 7 and Chapter 11. Once bankruptcy proceedings are started (whether through Chapter 7 or Chapter 11), creditors cannot attempt to collect debt from the business until the bankruptcy process has ended.
If you are a small business owner who is struggling with a lot of debt, Chapter 7 bankruptcy may help you in this situation. Chapter 7 bankruptcy can eliminate most or all of the debts that you are liable for. If you are a sole proprietor or your business is considered a general partnership, you are personally liable for your business’s debts, and you may also be able to file a Chapter 7 to eliminate most or all of your debt.
However, if your business is a separate legal entity, such as a corporation or LLC, you must file a bankruptcy on behalf of the business. While you may be able to use Chapter 7 in this situation, you’ll need a lawyer to represent you.
Each type of bankruptcy has its own advantages and disadvantages:
- Chapter 7
- Quicker and simpler than chapter 11
- Only one court visit (to file the petition)
- Some property must be sold
- Requires a court appointed trustee to manage the bankruptcy
- Business is unlikely to continue operation after bankruptcy
- Chapter 11
- Business is likely to continue operating after bankruptcy
- Property need not be sold
- No trustee is necessary since the business will continue to operate
- Longer and more complex than chapter 7
- Debts must eventually be paid
Chapter 7 bankruptcy involves the selling off (or "liquidation") of a business’ property to pay off debts. The bankruptcy process starts when the business files a petition with the bankruptcy court. The petition must list all of the business’ property, debts, and recent financial history.
The court will then appoint a trustee who will sell off some of the business’ property to help pay the business’ debts. The trustee will discharge some debts. This means that the debts will not have to be paid. Other debts are not dischargeable, including recent taxes, debts in prior bankruptcy, and penalties payable to the government.
After all the debts have been settled, the business will most likely cease to exist.
Chapter 7 bankruptcy is liquidation bankruptcy for both businesses and individuals. However, there are subtle differences if the debtor is a business rather than an individual:
- Only individuals have to take credit counseling as a prerequisite to filing for bankruptcy. If the debtor is a corporation or other non-individual business entity, the debtor does not have to take credit counseling.
- If the debtor is a corporation or other non-individual business entity, the debtor must be represented by a lawyer. Individual debtors may represent themselves.
- Only individuals can convert their Chapter 7 bankruptcy into Chapter 13 bankruptcy.
- Only businesses can convert their Chapter 7 bankruptcy into a Chapter 11 bankruptcy. If the debtor is a sole proprietorship though, the individual who owns the business may convert into Chapter 11.
Chapter 11 bankruptcy allows a business to reorganize its finances, eventually pay off its debts, and continue operating once bankruptcy is complete. This process starts when the business files a petition for Chapter 11 with the bankruptcy court. The business is then given 120 days to come up with a plan to reorganize the business in a profitable way.
To make the business profitable again, the plan might involve cutting off certain unprofitable parts of the business, such as discontinuing an advertising or research department. The plan must also detail how the business will pay off its creditors in the future. The plan must be approved by the creditors before a business can get out of a chapter 11 bankruptcy.
Many debts that drive business can be discharged in a Chapter 7 bankruptcy. When a debt is discharged, it means that the business owner is not personally liable for the debt and is no longer responsible for paying the debt once the bankruptcy case is complete. Remember that a Chapter 7 personal bankruptcy only discharges the business owner’s personal debt. If the business is a LLC or corporation, the creditors can still go after the debt that the business is liable for.
Here are some of the types of debts that are discharged in a Chapter 7 personal bankruptcy:
- Credit card bills
- Lawsuit judgments
- Medical bills
- Unsecured business debt owed by the business owner
- Personal loans and/or promissory notes
Filing for business bankruptcy can be very complicated and frustrating. Having a business attorney help your business through bankruptcy can make the process easier. An attorney has prior experience dealing with bankruptcies and is familiar with your state’s laws and regulations concerning bankruptcy.